MF portfolio construction – Avoid Balanced funds

Some people have come back to me after seeing my portfolio and questioned me as to why I do not invest in Balanced funds? Well, the short answer to that is, investment in Balanced funds as part of a long term MF portfolio is unnecessary, not only for me but for any serious investor. If you are looking for a longer answer then you must read this post carefully.

Before I even get to that, let me acknowledge that several Balanced funds have given great returns over a period of time. You will actually expect them to do no less as they are having 65 – 70 % in equity and our markets by and large have done well for the last few years. Even when they did badly the volatility in the Balanced funds were less. Again, you would expect this as the debt part will  dampen the volatility. These two aspects, namely decent returns and low volatility are normally cited as reasons as to why one should invest in Balanced funds. Why do I not feel the same way then?

The most important reason is that I do not believe in mixing asset classes or investment objectives. Every financial planner worth his salt will tell you that you must avoid mixing insurance and investment today – they did not do so a few years back when they were peddling ULIP seriously. Similarly, they should also be telling you that it does not make sense to mix two asset classes debt and equity in a single product. Instead they may tell you of inbuilt asset allocation that a Balanced fund will give you and some will even go as far as to say that you only need a single Balanced fund to meet all your needs.

Long term investing is about having 3 portfolios with very specific objectives – a debt portfolio to form a stable base and ensure that you do not sell equities at the wrong time, a MF portfolio to meet most of your financial goals and a stock portfolio to give a kicker to your returns that you will need at retirement. There is absolutely no need to have Balanced funds here. If the markets are doing well you do not need them – you want 100 % of your invested money to get the benefit of growth not only 65 % of it. If the markets are doing badly you want to buy more diversified equity MF to get benefit of lower purchase price. So you have a product that you do not really need in good times or in bad times of the markets. I hope you get the point.

So who does need a Balanced fund? Well, I really had to stretch for this but I could come up with these set of answers :-

  1. New investors into MF so that they can understand how the instrument works.
  2. Passive investors who do not want to invest in debt separately or manage their own asset allocation.
  3. People with no time to review or monitor their portfolios on their own.

Now, the fact that you are reading this post probably indicates that you are not in any of these categories, so you should really not be investing in a Balanced fund. Doing it already – well, there is no rule which says you cannot stop. On a more serious note, you need to give your equity investments the maximum chance to grow and Balanced funds are simply not the right product to achieve this objective. It does not matter how many people tell you to do so, what is wrong cannot be made right even if the majority opinion says so.

Sector funds are the other set of funds you should stay away from, but that is a topic for the next post.

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9 thoughts on “MF portfolio construction – Avoid Balanced funds

  1. Sir ,
    An amazingly simple to understand post as usual and makes complete sense. I have a small pointed question , pls. answer whenever you find time , this is about the difference between (the returns of ) direct and non direct/regular mutual funds and how (if) to change from regular to direct , and how.I think many of us have now been able to identify how to go about creating a MF portfolio and the ones among us who have been previously invested in funds that we want to continue , I think it will make sense if we can migrate from regular to direct.

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    • Thank you Vikas. The best way will be to sell off your holdings in the Regular fund and buy the units of Direct plans. I do not know if all fund houses allow switching or not, in any case that will be more cumbersome.

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  2. Dear Mr. Roy,

    You have mentioned that Balanced Funds should not be invested for long term, however the investors can invest for their medium term goals of 3-5 years. N in fact many Balanced Funds have beaten the Large cap funds in the long term. Giving a return of 17-18% which is not bad. In fact it is automatic rebalancing of the portfolio.

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    • Dear Vishal,

      You have a misconception like most people in this regard. Balanced funds invest 35% in debt and therefore they can never beat a similarly well constructed portfolio of another equity fund. It is simply not possible mathematically, think about it. Yes, you need to have debt investments and asset allocation but you do not need to do this through a product such as Balanced funds.

      Hope you got my point. Thanks. Raj

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    • These are the 3,5 and 10 year returns of top performing,long tenured diversified equity funds against their balanced fund peers within the same fund house. (Source VORL).

      BSL FrontLine Equity 25.4 (3y); 18.0 (5y); 15.8 (10y)
      BSL Balanced 25.4 (3y); 16.5 (5y); 15.4 (10y)

      ICICI Top 100 21.9 (3y); 17.0 (5y); 12.6 (10y)
      ICICI Balanced 25.2 (3y); 17.8 (5y); 13.0 (10y)

      Franklin Prima Plus 29.8(3y); 18.7 (3y); 15.8 (10y)
      Franklin Balanced 25.8 (3y) 16.7 (5y): 13.5 (10y)

      Does this mean that above Diversified funds failed to put 100% of invested money to gain the benefit of growth?.The tax that you need to pay if you maintain a pure debit fund nullifies the small difference in returns. How do you think these numbers support your view on Balanced fund?

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      • The returns are a factor of several aspects, stock selection is the most prominent of these. If stock selection and handling is the same and the market is doing well, it is not possible for a Balanced fund to match the returns of a pure equity fund. The figures you quote for 5 and 10 years have years like 2011 and 2008 inherent in them. While markets will do badly from time to time, these are clearly aberrations which have led to this situation.
        My method is always to look at fundamentals and there I see no reason to mix debt and equity in an investment product. If you want to mix it then my preference will be for MIP or Equity Savings Funds and not Balanced funds.

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      • The above comparison says it all, in fact – in a long term comparison -there is only +-2% difference between MIP (Debt+) – Hybrid(Equity+) – Equity Funds (Large Cap) [Excluding Mid Caps – Top 200*/Mid cap* ]

        an investor can optimize his return based on relative strength of the upside (probability)

        Blindly following thumb rules could be dangerous

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